The Final Court to the Split

THE FINAL COURT TO THE SPLIT: COULD IN RE ARCHDIOCESE GIVE THE EIGHTH CIRCUIT A CHANCE TO WEIGH IN ON NONCONSENSUAL THIRD-PARTY RELEASES IN CHAPTER 11 BANKRUPTCY PROCEEDINGS?

By: Emily Muirhead McAdam, Volume 102 Staff Member

The United States Bankruptcy Court for the District of Minnesota weighed in recently on a long-running debate in Chapter 11 proceedings: may a court confirm a plan for reorganization that includes a nonconsensual third-party release?[1] In the context of this case, In re Archdiocese of Saint Paul and Minnesota (“In re Archdiocese”), and the cases discussed in this Post, a “third-party release” is “a provision in a plan of reorganization that releases claims asserted by a creditor against a non-debtor defendant.”[2] In In re Archdiocese, the Archdiocese (the debtor) sought a release for third-party insurers and parishes from future claims brought by victims of sexual abuse.[3] Some courts hold that such a release may be granted even when the creditor objects—hence the term nonconsensual third-party release.[4] The circuit courts are split on the matter, however, with the Eighth Circuit being the only one to not yet weigh in.[5] Given the decision in In re Archdiocese, this Post explores this circuit split and looks ahead to what an Eighth Circuit decision on the matter could mean for this debate.

I. THE CIRCUIT SPLIT

The debate about whether a court may confirm a plan for reorganization that includes a nonconsensual third-party release tends to center on three provisions of the United States Bankruptcy Code: 11 U.S.C. §§ 105(a),[6] 1123(b)(6),[7] and § 524(e).[8] Section 105(a) allows the court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”[9] Section 1123(b)(6) states that a plan may “include any other appropriate provision not inconsistent with the applicable provisions of this title.”[10] As discussed below, a number of courts have pointed to these provisions as allowing a plan to include nonconsensual third-party releases. Courts that do not allow such releases, however, point to § 524(e), which states that the “discharge of a debt of the debtor does not affect the liability of any other entity on . . . such debt.”[11] It is worth exploring how courts have reached these opposing viewpoints.

A. Circuits that Allow Nonconsensual Third-Party Releases

The First, Second, Fourth, Sixth, Seventh, Eleventh, and D.C. Circuits have all concluded that nonconsensual third-party releases are allowed under the Bankruptcy Code.[12] In some cases, the courts relied on the broad grant of equitable power contained in 11 U.S.C. § 105(a).[13] Other courts relied on both § 105(a) and § 1123(b)(6), allowing courts to include “appropriate” provisions not inconsistent with the Bankruptcy Code.[14] Additionally, the Third Circuit has indicated that it too would allow nonconsensual third-party releases under the right circumstances.[15] These courts generally reason that, because nonconsensual third-party releases are not expressly prohibited under the Bankruptcy Code, and because § 105(a) allows bankruptcy courts to issue “any order, process, or judgment that is necessary or appropriate,”[16] it is within the court’s power to approve a nonconsensual third-party release in “appropriate circumstances.”[17]

Courts that allow nonconsensual third-party releases typically follow a similar reasoning to determine whether it is appropriate to allow a nonconsensual third-party release. Generally, nonconsensual third-party releases will be approved for only the most “unusual” or “unique” circumstances.[18] Where such circumstances exist, the courts will look to the presence of certain factors to determine whether the release is appropriate. Those factors look at whether:

(1) [t]here is an identity of interests between the debtor and the third party . . . such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete the assets of the estate; (2) the non-debtor has contributed substantial assets to the reorganization; (3) the injunction is essential to reorganization, namely, the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against the debtor; (4) the impacted class, or classes, have overwhelmingly voted to accept the plan; (5) the plan provides a mechanism to pay for all, or substantially all of the class or classes affected by the injunction; (6) the plan provides an opportunity for those claimants who choose not to settle to recover in full . . . .[19]

Some of these factors may be easier to meet than others, as was shown recently in In re Archdiocese.[20]

B. Circuits that Do Not Allow Nonconsensual Third-Party Releases

The Fifth, Ninth, and Tenth Circuits have all rejected nonconsensual third-party releases except in mass-tort asbestos cases wherein they are allowed under 11 U.S.C. § 524(g).[21] These courts all point to § 524(e) as foreclosing nonconsensual third-party releases.[22] There are also numerous scholars and practitioners who argue that the Bankruptcy Code does not allow courts to approve plans containing nonconsensual third-party releases.[23] There are arguments to be made that are beyond the scope of this Post that nonconsensual third-party releases are not only not allowed under the Bankruptcy Code, but are also an unconstitutional exercise of a bankruptcy judge’s power.[24] The view that nonconsensual third-party releases are not allowed, however, remains the minority.

II. FITTING IN RE ARCHDIOCESE INTO THE CIRCUIT SPLIT

The court in In re Archdiocese came down on the side of the majority of circuits and held that nonconsensual third-party releases “are permissible and . . . can be confirmed under appropriate circumstances.”[25] The court went on to say that, under appropriate circumstances, a release may be proper where the debtor can show:

(1) large or numerous liabilities against the debtor and the co-liable parties to be released, (2) a substantial contribution from the non-debtor co-liable parties, (3) the importance of the third party release to the reorganization process, and (4) significant acceptance of the plan by the group of creditors who are being asked to give up their claims against third parties.[26]

Of these, the court found that the debtor had not satisfied the fourth factor. Indeed, the class of sexual abuse victims in question had “overwhelmingly rejected the debtor’s plan.”[27] The court ultimately denied confirmation of both the debtor’s and committee of unsecured creditors’ plans, sending the parties back to mediation.

Given the high profile of the Archdiocese bankruptcy proceedings here in the Twin Cities, it is possible this case may still make its way to the Eighth Circuit. If it does, will the Eighth Circuit agree that nonconsensual third-party releases are allowed under appropriate circumstances? Or, will the Eighth Circuit side with the minority view? Considering the ubiquity of nonconsensual third-party releases in Chapter 11 plans for reorganization,[28] this question is sure to be considered sooner rather than later.

In re Archdiocese, 2017 BL 465425, at *10. In that case, the court stated that in order to confirm a plan, “the debtor must show (1) large or numerous liabilities against the debtor and the co-liable parties to be released, (2) a substantial contribution from the non-debtor co-liable parties, (3) the important of the third party release to the reorganization process, and (4) significant acceptance of the plan by the group of creditors who are being asked to give up their claims against third parties.” Id.↑